# Delving into Working Capital Turnover Ratio: A Comprehensive Guide

The Working Capital Turnover Ratio is a financial metric that assesses a company’s efficiency in using its working capital to generate sales revenue. This ratio helps businesses understand how effectively they’re leveraging their capital to drive sales and operate efficiently. Let’s dive into a comprehensive explanation of this crucial financial metric.

The Working Capital Turnover Ratio, also known as inventory turnover ratio. It shows how good a company is at using its money to make sales. It’s like seeing how well a lemonade stand uses its lemons and sugar to sell lemonade.

##### Why it matters?

Working capital is like the money a company needs to keep its doors open and run its day-to-day business. It’s the difference between what the company has on hand (current assets) and what it owes to others (current liabilities).

1. It measures how efficiently a company utilizes its working capital to generate sales over a specific period.
2. It evaluates the company’s ability to convert working capital into revenue.
3. It represents the number of times a company’s working capital is turned into revenue during a specific period, typically a fiscal year.
4. It measures how well all the money is used for sales.
5. It focuses on how well the money for daily operations makes sales.

### Formula and Calculation

It’s calculated by dividing net sales by average working capital.

###### Formula:

Working Capital Turnover Ratio = Net Sales / Average Working Capital

###### Calculation:

To calculate the working capital turnover ratio, follow these steps:

1. Determine Net Sales: Net sales refer to a company’s total revenue after deducting returns, discounts, and allowances.
2. Calculate Average Working Capital: Average working capital is the average of the beginning and ending working capital balances for the period. Working capital is calculated by subtracting current liabilities from current assets.

## Types of Working Capital Turnover Ratio

Inventory Turnover Ratio: This ratio specifically measures how quickly a company sells its inventory, indicating its efficiency in managing inventory levels.

###### 1. Operating Working Capital Turnover Ratio: Focuses on operational efficiency by considering operating working capital

Formula: Net Sales / Operating Working Capital

###### 2. Total Working Capital Turnover Ratio: Measures overall efficiency in using total working capital

Formula: Net Sales / Total Working Capital

##### 3. Inventory Turnover Ratio = This ratio specifically measures how quickly a company sells its inventory, indicating its efficiency in managing inventory levels.

Formula: Inventory Turnover Ratio = Cost of Goods Sold / Average Inventory

##### 4. Account Receivable Turnover Ratio: This ratio assesses a company’s efficiency in collecting payments from its customers.

Formula: Account Receivable Turnover Ratio = Net Credit Sales / Average Accounts Receivable

##### 5. Days Sales Outstanding (DSO): DSO represents the average number of days it takes a company to collect payment from its customers. It is calculated as the inverse of the account receivable turnover ratio.

Formula: Days Sales Outstanding = 365 / Account Receivable Turnover Ratio

### Interpretation and Benchmarks

A higher working capital turnover ratio generally indicates that a company is efficiently utilizing its working capital, generating more sales per dollar invested in working capital.

Higher Is Better: A higher number means the money is used well to make more sales.

However, it is important to consider industry benchmarks, as different industries have varying working capital requirements.

• Efficiency Benchmark: Helps gauge how effectively a company manages its working capital resources.
• Higher Ratio Significance: A higher ratio indicates better utilization of working capital to generate sales revenue, showcasing efficient operations.
• Industry Comparison: Comparing this ratio to industry benchmarks provides insights into relative efficiency.
###### Benefits of Working Capital Turnover Ratio
• Identifying Efficiency: The working capital turnover ratio helps identify areas where a company can improve its efficiency, such as reducing inventory levels or accelerating collections.
• Evaluating Cash Flow: A strong working capital turnover ratio suggests that a company is generating cash efficiently, which can improve its liquidity and overall financial health.
• Making Informed Decisions: Investors and analysts use the working capital turnover ratio to assess a company’s financial performance and make informed investment decisions.

## Questions and Answers: Total Working Capital Turnover Ratio Examples

##### Example 1

| Date | Current Assets | Current Liabilities | Working Capital |
|—|—|—|—|
| 2022-01-01 | 100000 | 80000 | 20000 |
| 2022-01-31 | 120000 | 90000 | 30000 |
| 2022-02-28 | 130000 | 100000 | 30000 |
| 2022-03-31 | 140000 | 110000 | 30000 |
| 2022-04-30 | 150000 | 120000 | 30000 |
| 2022-05-31 | 160000 | 130000 | 30000 |
| 2022-06-30 | 170000 | 140000 | 30000 |
| 2022-07-31 | 180000 | 150000 | 30000 |
| 2022-08-31 | 190000 | 160000 | 30000 |
| 2022-09-30 | 200000 | 170000 | 30000 |
| 2022-10-31 | 210000 | 180000 | 30000 |
| 2022-11-30 | 220000 | 190000 | 30000 |

Average Working Capital = (20000 + 30000 + 30000 + … + 30000) / 12 = 30000
Net Sales = 2000000 (Assuming annual net sales of \$2,000,000)
Working Capital Turnover Ratio = Net Sales / Average Working Capital = 2000000 / 30000 = 6

In this example, the working capital turnover ratio is 68.57. This means that the company is generating \$68.57 of sales for every \$1.00 of working capital. This is a good indication that the company is efficiently managing its working capital.

##### Example 2: Total Working Capital Turnover Ratio Example:

Suppose a company has net sales of \$500,000 and total working capital of \$100,000:

Total Working Capital Turnover Ratio= (500,000/100,000​)=5

This means the company generates \$5 of sales revenue for every \$1 of total working capital.

##### Example 3: Operating Working Capital Turnover Ratio Example:

If the same company’s operating working capital is \$80,000:

Operating Working Capital Turnover Ratio= (500,000/80,000)​=6.25

This implies the company generates \$6.25 of sales revenue for every \$1 of operating working capital.

### Conclusion

The working capital turnover ratio serves as a valuable tool for understanding a company’s ability to manage its working capital effectively. By analyzing this ratio and comparing it to industry benchmarks, investors and analysts can gain insights into a company’s operational efficiency and financial health.

Photo credit: stevepb via Pixabay

Financial Ratios are like performance scorecards for businesses | Accounting – Formulas, Examples, Questions, Answers